Economics in One Lesson

by Henry Hazlitt

The Lesson Applied

“Stabilizing” Commodities

Attempts to lift the prices of particular
commodities permanently above their natural market levels have failed so
often, so disastrously and so notoriously that sophisticated pressure
groups, and the bureaucrats upon whom they apply the pressure, seldom openly
avow that aim. Their stated aims, particularly when they are first proposing
that the government intervene, are usually more modest, and more
plausible.

They have no wish, they declare, to raise the price of commodity X
permanently above its natural level. That, they concede, would be unfair to
consumers. But it is now obviously selling far below its
natural level. The producers cannot make a living. Unless we act promptly,
they will be thrown out of business. Then there will be a real scarcity, and
consumers will have to pay exorbitant prices for the commodity. The apparent
bargains that the consumers are now getting will cost them dear in the end.
For the present “temporary” low price cannot last. But we cannot afford
to wait for so-called natural market forces, or for the “blind” law of
supply and demand, to correct the situation. For by that time the producers
will be ruined and a great scarcity will be upon us. The government must
act. All that we really want to do is to correct these violent,
senseless fluctuations in price. We are not trying to boost
the price; we are only trying to stabilize it.

There are several methods by which it is commonly proposed to do this.
One of the most frequent is government loans to farmers to enable them to
hold their crops off the market.

Such loans are urged in Congress for reasons that seem very plausible to
most listeners. They are told that the farmers’ crops are all dumped on
the market at once, at harvest time; that this is precisely the time when
prices are lowest, and that speculators take advantage of this to buy the
crops themselves and hold them for higher prices when food gets scarcer
again. Thus it is urged that the farmers suffer, and that they, rather than
the speculators, should get the advantage of the higher average price.

This argument is not supported by either theory or experience. The
much-reviled speculators are not the enemy of the farmer; they are essential
to his best welfare. The risks of fluctuating farm prices must be borne by
somebody; they have in fact been borne in modern times chiefly by the
professional speculators. In general, the more competently the latter act in
their own interest as speculators, the more they help the farmer. For
speculators serve their own interest precisely in proportion to their
ability to foresee future prices. But the more accurately they foresee
future prices the less violent or extreme are the fluctuations in
prices.

Even if farmers had to dump their whole crop of wheat on the market in a
single month of the year, therefore, the price in that month would not
necessarily be below the price at any other month (apart from an allowance
for the costs of storage). For speculators, in the hope of making a profit,
would do most of their buying at that time. They would keep on buying until
the price rose to a point where they saw no further opportunity of future
profit. They would sell whenever they thought there was a prospect of future
loss. The result would be to stabilize the price of farm commodities the
year round.

It is precisely because a professional class of speculators exists to
take these risks that farmers and millers do not need to take them. The
latter can protect themselves through the markets. Under normal conditions,
therefore, when speculators are doing their job well, the profits of farmers
and millers will depend chiefly on their skill and industry in farming or
milling, and not on market fluctuations.

Actual experience shows that on the average the price of wheat and other
nonperishable crops remains the same all year round except for an allowance
for storage, interest and insurance charges. In fact, some careful
investigations have shown that the average monthly rise after harvest time
has not been quite sufficient to pay such storage charges, so that the
speculators have actually subsidized the farmers. This, of course, was not
their intention: it has simply been the result of a persistent tendency to
overoptimism on the part of speculators. (This tendency seems to affect
entrepreneurs in most competitive pursuits: as a class they are constantly,
contrary to intention, subsidizing consumers. This is particularly true
wherever the prospects of big speculative gains exist. Just as the
subscribers to a lottery, considered as a unit, lose money because each is
unjustifiably hopeful of drawing one of the few spectacular prizes, so it
has been calculated that the total value of the labor and capital dumped
into prospecting for gold or oil has exceeded the total value of the gold or
oil extracted.)

The case is different, however, when the State steps in and either buys
the farmers’ crops itself or lends them the money to hold the crops off
the market. This is sometimes done in the name of maintaining what is
plausibly called an “ever-normal granary. But the history of prices and
annual carryovers of crops shows that this function, as we have seen, is
already being well performed by the privately organized free markets. When
the government steps in, the ever-normal granary becomes in fact an
ever-political granary. The farmer is encouraged, with the taxpayers’
money, to withhold his crops excessively. Because they wish to make sure of
retaining the farmer’s vote, the politicians who initiate the policy, or
the bureaucrats who carry it out, always place the so-called fair price for
the farmer’s product above the price that supply and demand conditions at
the time justify. This leads to a falling off in buyers. The ever-normal
granary therefore tends to become an ever-abnormal granary. Excessive stocks
are held off the market. The effect of this is to secure a higher price
temporarily than would otherwise exist, but to do so only by bringing about
later on a much lower price than would otherwise have existed. For the
artificial shortage built up this year by withholding part of a crop from
the market means an artificial surplus the next year.

It would carry us too far afield to describe in detail what
actually happened* when this program was applied, for
example, to Amencan cotton. We piled up an entire year’s crop in storage.
We destroyed the foreign market for our cotton. We stimulated enormously the
growth of cotton in other countries. Though these results had been predicted
by opponents of the restriction and loan policy, when they actually happened
the bureaucrats responsible for the result merely replied that they would
have happened anyway.

For the loan policy is usually accompanied by, or inevitably leads to, a
policy of restricting production — i.e., a policy of scarcity. In nearly
every effort to “stabilize” the price of a commodity, the interests of
the producers have been put first. The real object is an immediate boost of
prices. To make this possible, a proportional restriction of output is
usually placed on each producer subject to the control. This has several
immediately bad effects. Assuming that the control can be imposed on an
international scale, it means that total world production is cut. The
world’s consumers are able to enjoy less of that product than they would
have enjoyed without restriction. The world is just that much poorer.
Because consumers are forced to pay higher prices than otherwise for that
product, they have just that much less to spend on other products.

* The cotton program has been, however,
an especially instructive one. As of August 1, 1956, the cotton carryover
amounted to the record figure of 14,529,000 bales, more than a full year’s
normal production or consumption. To cope with this, the government changed
its program. It decided to buy most of the crop from the growers and
immediately offer it for resale at a discount. In order to sell American
cotton again in the world market, it made a subsidy payment on cotton
exports first of 6 cents a pound and, in 1961, of 8.5 cents a pound.
This policy did succeed in reducing the raw-cotton carryover. But in
addition to the losses it imposed on the taxpayers, it put American textiles
at a serious competitive disadvantage with foreign textiles in both the
domestic and foreign markets. The American government was subsidizing the
foreign industry at the expense of the American industry. It is typical of
government price-fixing schemes that they escape one undesired consequence
only by plunging into another and usually worse one.[4]